When Housing Hijacks an Economy

–There is absolutely nothing we can add today to your understanding of what is happening on the Korean Peninsula. But it sure has prompted a mini “flight to safety” rally. The gold price was up nearly 1.6% up in U.S. dollar terms. That in itself was an achievement because the greenback rallied against its arch-rival the Euro at the same time.

–Before we delve even further into the sub-basement of the world economy, a quick note about yesterday’s reckoning. A reader wrote in asking us if we went to bed at night dreaming/fantasizing about the collapse of the banking system in the developed world, implying that there was something both perverted and off-putting about such a desire.

–But don’t worry. That’s not our desire. Our main point was that there is already a system for dealing with bad loans made by bank officers: it’s called bankruptcy. The EU/IMF solution to Ireland’s problem is to borrow from someone else to pay for the mistakes made by the Irish banks. The people who should really lose money, as Jim Rogers pointed out overnight, the shareholders and bondholders in the banks. This is not a risk free world we live in.

–Rogers pointed out that Ireland’s banks borrowed up to 80% of Irish GDP to fund that country’s property boom. A lot of the loans went to developers as well as individual borrowers. When the property market went bust after the banks soon turned to the European Central Bank for repeated helpings of credit to delay the inevitable. This week, the inevitable arrived.

–Could such a thing happen here? Well, according to the June issue of APRA’s always-scintillating “Quarterly Bank Performance,” Aussie banks have a combined $1.45 trillion in housing loans. The report says, “The banks showed a 4.0 per cent decrease in total assets over the year to 30 June 2010, driven predominantly by falls in other assets. Total housing loans increased by 12.3 per cent to $1,145.0 billion over the year.”

–Hmm. So total housing loans (assets) for banks are about equal to total GDP. Now keep in mind Aussie banks have not borrowed all that money from abroad. Just some of it (quite a lot of it). This is one reason why Australia’s net foreign debt is around $670 billion. The housing boom has been financed with foreign money.

–That’s not a problem, unless foreign money gets expensive or is no longer as forthcoming. As long as you can sell bonds to foreign borrowers you’re alright. But it’s a bit of a worry for the major banks, based on the charts below from the RBA, that foreigners may not be as keen to buy bonds issued by Aussie banks, although keep in mind the banks might not be keen to sell debt right now either when they can raise money through equity financing.

–All three charts show that conventional and unconventional debt instruments have all declined as a source of funding since the GFC. The government has stepped in the Residential Mortgage Backed Securities (RMBS) market to support non-bank lenders and offer other sources of competition for bank lending. But for the most part, the unconventional sources of asset securitisation haven’t recovered to their pre-crisis highs.

–Which brings us to covered bonds. No, it’s not a new type of underwear. It’s a source of funding for banks which uses deposits as collateral against default. In other words, the bank sells a security and the buyer of the security is first in line to be paid from bank deposits in the event that the bank is wound up.

–You might wonder why a lender would have first access to bank deposits ahead of, say the depositor himself (you). And that’s a fair question. It’s also why covered bonds are a bit controversial. Putting creditors ahead of depositors in line for the distribution of assets would be a public relations disaster.

–But it would only be a disaster if the bank is actually wound up and creditors (the buyers of covered bonds) get your money while you (the depositor) get nothing. And of course, if a bank sources just a small portion of its funding from covered bonds, it doesn’t represent a mortal threat to depositors and their deposits (you and your money in the bank).

–Yet it’s telling that the Gillard government and Treasurer Wayne Swan are considering the introduction of covered bonds in Australia. Joe Hockey likes this idea, which should scare you even more. It’s a bi-partisan agreement on how to put housing even more at the epi-centre of Australia’s economy. Anytime politicians from the major parties agree on something, it’s bound to be bad for you.

–The Big Four would claim that covered bonds are an additional source of funding for the housing boom that allows banks to lower borrowing costs to Australians because it lowers their aggregate cost of funding. But remember, the collateral for the bonds is your money in the bank.

–What could possibly go wrong?

–Well, hypothetically, a fall in bank asset values (housing crash) would raise concerns about bank liquidity and lead to doubts about the likelihood of a bank paying out on its covered bonds. This is what has happened in Ireland.

–When Anglo-Irish Bank had ratings on its covered bonds cut by Moody’s, it showed that the Irish banks increasingly at the mercy of the ECB for continuous funding and that alternate sources of funding were tapped out. It also meant that the collateral for the bonds was in doubt, and forced the Irish government to try to make it good.

–This last point is really the most important. Covered bonds were just the last in a long-line of ideas to keep Ireland’s housing boom going beyond all bounds of normality. Once the money ran out to keep prices inflating, the housing market collapsed and took the entire banking sector with it. This is how housing hijacks an economy.

–So what does all this have to do with Australia? Well, in our view, Australia’s market has been partially hijacked by housing. Covered bonds would only make the bubble bigger, which would make housing even more unaffordable and lead to bigger losses down the track.

–The recourse to covered bonds is being sought to keep the housing bubble from deflating. The banks, having exhausted the supply of first buyers, need to find new sources of funding to offer new mortgage products. And they might be worried that the traditional sources of funding are getting more expensive and more reluctant to feed Australia’s bubble.

–The big risk with covered bonds is that they get abused as cheap of way of sourcing funding for reckless lending. It works as long as house prices go up and up. But if house prices fall, then not only are depositors imperilled, but the government will be asked to help the banks with more cash to pay off investors. And when the value of bank loans exceeds GDP, not even the government can make that good.

–Of course that could never happen here.

–By the way, covered bonds are legal now in New Zealand. In fact, kiwi banks are selling the bonds denominated in foreign currency, which you think would expose them to massive currency risk. Incidentally, Aussie banks have a heaping helping of assets. We’ll get the figures for you tomorrow.

— And finally, get a load of this from Dow Jones Newswires overnight: Standard & Poor’s Monday shifted its outlook on New Zealand’s foreign currency credit rating to negative from stable, warning on the country’s dependence on offshore markets to fund its banking network and putting a spotlight on the its tepid economic recovery.

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

“sell debt right now either when they can raise money through equity financing”. You don’t have to have a long memory to recall boards calling equity finance as being prohibitively expensive compared to debt and you can go back through the history of the boom and bust cycle economic cycle to see the same thing over and over. But if you have bodgy balance sheets and pay big dividends you can report higher equity with ratios that look on the surface reasonably in line and then you can borrow more money. This was the story of the 1960 era consumer… Read more »

If I recall correctly, the DJIA turned around nicely right about the time GWB announced the Marines were off to have a really stern chat to Saddam Hussein too Ross? Read a bit of history and one gets thoroughly sick of seeing the same nonsense games played again and again.

This covered bond business disturbs me a lot – some irresponsible politicians are presenting it as some panacea to lower funding costs. But basically it is transferring risk away from bondholders (who therefore demand a lower interest rate) towards depositors (who are in a much weaker position to force compensation for the increased risk they are exposed to).

If this is introduced, I’d expect that the Australian dollar would become (even) more volatile, as capital fled on any negative sentiment.

Spanish bonds hit record. Non PIIGS Belgium dragged into contagion. Euro takes a big dip in past 12 hours. http://www.businessspectator.com.au/bs.nsf/Article/UPDATE-2-Spain-tries-to-calm-markets-warns-Germany-BHM8J?OpenDocument&src=hp13 Separately Irish bailout talk by Dutch now including haircuts for bank shareholders and “subordinated bondholders”. Aussie banks have $4 billion in bonds according to Jacqueline Maley. NAB was biggest in Ireland offhand by my dodgy memory. Issue though is that any announcement of a haircut or political backdown on sovereign guarantee of new funding will have a positive feedback raising spreads even higher. A 250 basis point spike for AU-NZ wholesale funding like the Spanish premium over the bunds is… Read more »

Have we ever considered that realtors aren’t getting much action, while potential sellers are: a.) holding b.) insisting on their asking prices (?)

In that scenario we hear from them that sellers must ask ‘realistic’ prices. Realtors aren’t getting the action they’ve enjoyed for years. The most successful _are_ still getting volume, with some sellers accepting silly offers. That’s not to say that some of the asking prices aren’t silly.
They are… . ;)

I’m still punting that it’s correction time in Brissie Biker. I’ll be a serious looker after a 15% drop IF the mining boom is still looking ‘safe as houses’! ;) No really significant correction here yet though. Despite the fact we’ve been under pressure for maybe 10 months now. Bank interest rate on my cash is looking OK for now given the expectation of no housing price growth. And quite possibly a correction in it. Just take it as it comes for at least 6 more months I’m thinking. “potential sellers are: a.) holding b.) insisting on their asking prices”… Read more »

Comment by Ned S on 28 November 2010: I’m still punting that it’s correction time in Brissie Biker. I’ll be a serious looker after a 15% drop 15% drop is around my expectations for Melbourne next year as well. A lot of it’s just going to come back to a) how many over leveraged sellers there are that ‘blink’ at the thought of holding through any down turn Enough in Melbourne to have a definitive effect on the housing market. b) whether there really is a shortage A shortage of quality homes in quality locations… for sure.. the shortage of… Read more »

Noosa’s Hotel California Robert Gottliebsen Published 7:42 AM, 29 Nov 2010 Last update 10:35 AM, 29 Nov 2010 Noosa Heads, Australia, is a long way from Ireland and California but it has experienced a similar real estate shock – a 70 per cent fall in the value of a major property. It’s a long time since Australia has seen prime property fall by that much. In all Resort Corporation spent $210 million on the Noosa Sanctuary resort and clearly believed that the market value of what they were creating was much higher than that. The project went into receivership and… Read more »

Just keep doing what you’ve been doing now is my general thought Steve. And don’t buy anything for at least 6 months maybe – And quite possibly longer after reviewing in 6 months? Though in truth I don’t actually know anything much at all about the Sydney market and don’t want to except as in so far as it might affect the Brissie market.

One of the reasons I keep a general eye on Sydney and Melbourne Shoes, is that providing they don’t get too severely challenged, I doubt interest rate drops or stimulus aimed specifically at housing are too likely to be forthcoming. So agree they are good to watch generally. But not specifically (for me) being in Brissie.

I see Big Red reckons she wants to actually achieve something over the next 2 yrs??? Not sure why? But anyway, her suggestions: * Legalise same sex marriages – Yeah; On the proviso the Sydney Mardis Gras ceases forthwith and no-one ever has to hear anything about gays ever again. (They really have gotten to be a seriously tiresome, tedious and annoying little self interest group that no-one could possibly give a toss about anymore surely? Except for the hope they’ll cease and desist from their attention seeking and self aggrandising ways.) * Carbon Tax – Yeah; As a concerned… Read more »

I see Big Red reckons she wants to actually achieve something over the next 2 yrs??? Not sure why? But anyway, her suggestions: * Legalise same seks (it’s DRA’s required spelling) marriages – Yeah; On the proviso the Sydney Mardis Gras ceases forthwith and no-one ever has to hear anything about gays ever again. (They really have gotten to be a seriously tiresome, tedious and annoying little self interest group that no-one could possibly give a toss about anymore surely? Except for the hope they’ll cease and desist from their attention seeking and self aggrandising ways.) * Carbon Tax –… Read more »

And there’s another proviso on the LGBT thing – If it all turns to poo in 40 yrs time and kiddies who’ve been adopted/raised by such couples reckon they were badly done by in comparison to what just might have otherwise been, then as opposed the “Stolen Generation”, as their daddies and daddies and their mummies and mummies or whateveries, please do be aware that this was totally your demand and choice as their whateveries. So no-one else can possibly be expected to be accountable in any way at all this time round. Your call, your demand, your choice, your… Read more »

I’m getting to know human nature just a bit more than I like I think. The baskets by and large always seem to want what they reckon will make them happy now. Providing they can ultimately say I didn’t know; I didn’t fully understand; Someone else should have told me – So it really WAS all someone else’s fault! Those sorts of human beings are ones the species very well could be genetically better off without – Is my thought.

Certainly a ‘soft’ realty market here; so ABS 9.4% lift in house prices in the last twelve months is possibly off the back of very poor ’08 – ’09 Perth figures. Our population grew 3.6% in the same period, the most in any capital. We expect even higher figures 2011 – 2012. Very large volume of homes for sale, so home construction is stalling. Some of the current stimulus building (public housing) is just coming to fruition. Much of it seems to be retirement complexes. Once that ends, mid-2011, it could be interesting. No idea what’s happening on the east… Read more »

Where a blogsite permits an advertiser six simultaneous, consecutive detailed comments, excluding views to the contrary, we’d have to question their bias, wouldn’t we… particularly when their links infest the site(?) You’ll recall I suggested WA is experiencing a soft market, with an unusually high number of homes for sale. Despite that, many good areas are up 18% or more. Others, Kwinana, for example ( ;) ) are way down. Rental demand in good areas is very, very high. Longest vacancy we’ve had in eighteen months was three days… . We were pleased and surprised. The rental glut is over…… Read more »

Auction Clearance Rates http://reiv.com.au/home/inside.asp?ID=162&nav1=1226&nav2=162 Saturday 11th December 2010 The clearance rate from the 1019 auctions reported today was 61 per cent, a good outcome in light of the record number of homes on the market this weekend On this weekend last year there was 1065 auctions and a clearance rate of 81 per cent recorded Similiar number of “supply” big difference in demand…. Was supposed to be around 1200 homes for Auction this weekend in Melbourne so stats are incomplete or all results not in (getting common for agents to not report non sales) Dress it any way you like..… Read more »

Terry Ryder cites Brissie and Perth as all go in 2011, Ned. If you’re going to do something, might be worth having a good look now.

Alan Bourke, REIWA’s man, is offering Premier Barnett a tempting alternative to Victoria’s $20K FHOG. The Vic plan appears to offer land sellers a bonus, as would Buswell’s WA $20K plan; but Bourke’s alternative, $15K, would apply equally to new and existing homes.

I’d be surprised if Colin Barnett passed up the REIWA plan, considering the population increases (2011 – 2012) predicted here.

He’s certainly going to be at odds with Matusik in that call though.
Truth be told, it seems we have an oversupply in SE QLD at least for now. Any more upward movements in interest rates could really rock this market – Is my punt?

Depending what happens I’ll start sniffing around for another buy mid 2011 maybe – But will be continuing to watch closely in the interim regardless.

Interest rates are predicted by some (the usual suspects!~ ;) ) to be on hold for six months, Ned. Mid-2011 puts you right on the date exit fees are to be abolished. May be a psychological effect there… or not(?) FHBs _may_ think that’s important… . Two lib state governments (Vic, WA) are almost certain to intervene in the market, meantime. Ryder also predicted rises in some key regional centres, particularly in WA. He lists those centres… . So much money whizzing about here, I can’t believe it. While some of our stuff appreciated just 7% last year, two of… Read more »

“We’ve seen no anecdotal evidence to support that, so we’re a little skeptical.” – One surely does have to do their own research mate. It’s all a bit crazy – Here we have a $3.5 t or just maybe $4 t market that that majority of Aussies hold the majority of their wealth in and if Ric Battellino of the RBA (I think it was him?) is asked how come do you reckon 10% of Oz housing isn’t occupied on census night, he replies Maybe because it’s mainly holiday homes??? God help them if anyone was to ask any difficult… Read more »

Interest rates – Curious one Biker – US Treasuries took a bit of a hit last week as I understand it? – Lower prices and higher interest rates if I understand it correct??? Wait and see – But if Bill Bonner’s long awaited ‘Revolt of the Bond Vigilantes’ just should be coming to pass, Mr Bernanke could find himself caught between the ultimate rock and a hard place in such a circumstance? Monetarise the debt? (Whatever the hell that means? Though I suspect it means that Ben buys it himself in the absence of any other willing purchasers???) Not me… Read more »

Ned: “What five year age brackets do property investors fall into?” Strange but true, nearly all of our tenants own homes, in some cases multiple investment homes. In the two best examples, the youngest would be around 33 and the oldest in his mid-forties. The latter fella has three worth around a million each. Although I’d had three properties by the time I was thirty, it was only in my mid-thirties that I/we got serious about property. Rates? Hard to know. You can currently lock in three years at 7.1% with either of two banks. (Our own two banks are… Read more »

Yes, it’s gotten ‘boaring’ as you say Biker … Chrissy coming up soon though – Time for a rest maybe? (Not bloody likely with tenants on the move soon and a leaky roof in another house! But it’s nice to dream sometimes … :) )

In Australia, about 1% of depositors’ money is ‘reserved’ as Non-callable deposits. The remainder is [or may be] loaned to borrowers.

If covered bonds are ‘covered’ by depositors’ funds, do these funds include those no longer available to the ‘banks’ without calling in the loans they have made, or only the 1% held by the Reserve Bank?

Either way, if the government is proposing to shield depositors through the Financial Claims Scheme, doesn’t this actually mean that the government [taxpayers] is in fact underwriting the covered bonds?

“Our colleague’s house in Melbourne has risen 200% in price since we sent her there four years ago. And it’s still going up.” Delightful!~

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